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Wednesday, February 15, 2012

Shareholder Interests Aren't All The Same

Management will act in its own best interests, and for this reason investors should ensure that management's interests are aligned with theirs. Sometimes, however, management may be swayed to act in the interests of major shareholders, whether under the threat of a hostile takeover or as part of a courtship process for a friendly merger. Investors armed with this knowledge are in a position to better understand what is about to take place, and may thus make investment decisions that are in tune with their investment strategies.

For example, value investors can take a hint as to the company's future capital allocation plans if a company under review already has a large shareholder with a history of a preference for companies which return capital to shareholders vs those which try to empire-build. But to the aspiring value investor, finding this information isn't always easy.

Shareholders who peruse SEC company filings will have come across Schedule 13d from time to time. This is a mandatory filing that must be submitted by anyone who owns more than 5% of a company. On this form, major shareholders are required to disclose who they are, their relationship to the company, and even the motivations behind the transaction (though that can be conveniently changed at a later time).

But even if the schedule itself does not make the motive of the purchase abundantly clear, researching the large investor's background may help clear up uncertainties with respect to the company's near-term future. For example, if Berkshire Hathaway has taken a large stake in a company, it may be seen as an endorsement of management. On the other hand, if Carl Icahn is the buyer, director and management changes may be on the way!

That management should act in the best interests of shareholders is often discussed, including on this site. Implicit in this idea, however, is the notion that all shareholder interests are the same. Unfortunately, this is not always the case. However, disclosures are available which can aid the shareholder in determining whether the interests of major shareholders are aligned with theirs.